While the world's (excluding China) direct selling market
generates an annual turnover of over US$89 billion with nearly
50 million sales personnel, many foreign companies are keen to
engage in direct selling in China, the potentially largest
market to be developed. "Direct selling" usually refers to
direct selling through sales representatives. The English term
has two possible translations in Chinese: chuanxiao
(??) and zhixiao (??). There are no unified definitions for
both terms in PRC legislation, and in business practice the
same problems exist. Following China's all-out ban on direct
selling in 1998, chuanxiao was viewed increasingly
negatively in the Chinese media and was often directly
associated with the notorious pyramid selling
schemes.1 Zhixiao, on the contrary, is now more
often used to mean legitimate direct selling (both multi-level
and single-level2), excluding pyramid schemes.

History of China's Legal Regime on Direct Selling

Direct selling has undergone two significant stages in
China. Prior to 1998, both multi-level and single-level direct
selling were allowed in China. However, having seen the
problems involving multi-level direct selling and an increasing
frequency in pyramid schemes, the Chinese government started
restricting multi-level direct selling, and launched crackdowns
on pyramid schemes. The government finally stopped approving
new multi-level direct selling enterprises in 1995. After
investigations of existing direct selling enterprises, only 57
enterprises were approved to engage in multi-level direct
selling (including Amway) and five enterprises to engage in
single-level direct selling (including Avon) by October
1996.

In 1998, China issued a notice to immediately ban all types
of direct selling on the concern that direct selling disturbed
the social order by creating closed and tightly knit
gangster-type organizations that would sell illegitimate or
low-quality products at exorbitant prices.

Shortly thereafter, the Chinese government issued another
notice requiring foreign-invested direct selling enterprises to
operate only through fixed stores. This method of direct
selling (since 1998) has imposed very restrictive qualification
and operational requirements. So far, only ten foreign-invested
enterprises (FIEs) have been approved to engage in this direct
selling mode, including Amway and Avon.

Upcoming Changes in China's Direct Selling Market

China promised to remove the current restrictions on direct
selling within three years of its WTO accession (i.e., by
December 11 2004). This was supposed to be realized through
domestic legislation by the end of 2004.

In a closed-door seminar held by the relevant Chinese
authorities in September 2004, 22 enterprises were invited to
discuss three legislative drafts on direct selling: the
Administration of Direct Selling (zhixiao) Procedures,
the Administration of Training of Sales Representatives
Procedures, and the Anti-pyramid Scheme Fraud
Regulations.

Based on various leaks, it appears that while pyramid
schemes will continue to be prohibited, both single-level and
multi-level direct selling (zhixiao) may be allowed.
However, the total economic compensation (including commissions
and bonus) of each sales representative may be capped at 25%
(or 30% with approval) of one's personal sales revenue, which
could severely limit the development of multi-level direct
selling.

Regarding the qualification requirements, it is reported
that: (i) FIEs will be required to have at least US$10 million
registered capital in China, more than three years of overseas
direct selling experience, manufacturing facilities and retail
stores in China, sell only their own products, and be a member
of the World Federation of Direct Selling Associations (WFDSA);
while (ii) domestically funded enterprises will need at least
an average of Rmb500 million (around US$60 million) annual
turnover for the past three years to qualify. Additionally, a
deposit of Rmb20-30 million (US$2.4-3.6 million) will be
required to cover any future consumer complaints.

The deadline of December 11 2004 has elapsed, but the new
rules have not been promulgated yet. It is reported that the
Chinese government has made further revisions to the draft
rules and it will take some time for the ministries involved to
agree on the final draft. These revisions may include: (i)
deletion of the Rmb500 million annual turnover requirement;
(ii) deletion of the WFDSA membership requirement; (iii)
expansion of the scope of products allowed for direct selling;
and (iv) limitation on the maximum compensation for sales
representatives to 25% without exception. However, other
qualification requirements appear to remain unchanged.

Since Chinese officials have repeatedly expressed their
concerns over the potential social problems that direct selling
brings, the new rules are expected to be cautious and
restrictive rather than progressive.

Endnotes

1 Pyramid scheme usually refer to marketing plans having the
following characteristics: (1) a high entry fee is charged to
new participants; (2) a clear distinction in rights between the
upper and lower levels in the pyramid; and (3) an income
structure whereby senior participants obtain fees not only from
new participants developed by themselves but also later
lower-level participants brought in by others. In China, such
schemes are viewed as fraudulent marketing plans that are not
based on selling products but are focused on entry fees paid by
each participant.

2 Based on the levels of compensation to sales
representatives. Multi-level sales representatives get
compensation not only for their sales revenues but also the
sales revenues achieved by other sales representatives
developed by them, while single-level sales representatives
only get compensation for their own sales revenues.